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Financial System – Meaning & Structure

Introduction

A Financial System is a network of financial institutions, financial markets, financial instruments, and financial services that facilitate the transfer of funds.

It acts as a bridge between:

  • Savers (Surplus Sector): Households, Individuals who save money.
  • Borrowers (Deficit Sector): Corporate, Government who need money for investment.

Definition: "A financial system acts as an intermediary effectively ensuring the smooth flow of funds from the savers to the investors."

1. Structure of Indian Financial System

The Indian Financial System is broadly classified into two categories:

A. Organized Sector

Regulated by authorities like RBI (Reserve Bank of India) and SEBI (Securities and Exchange Board of India). It consists of:

  1. Regulators: RBI, SEBI, IRDAI, PFRDA.
  2. Financial Institutions: Banks (SBI, HDFC), NBFIs (Bajaj Finance), Development Banks (NABARD).
  3. Financial Markets: Capital Market (NSE/BSE), Money Market.
  4. Financial Services: Insurance, Mutual Funds, Depositories.

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B. Unorganized Sector

Not strictly regulated by the government. Prevalent in rural areas.

  1. Indigenous Bankers: Private firms receiving deposits and lending money (e.g., Shroffs, Marwaris).
  2. Moneylenders: Individuals lending at high interest rates without taking deposits.
  3. Chit Funds: Local savings schemes (Some are now regulated).
Note

One of the biggest challenges for RBI is the Unorganized Sector, as it does not follow Repo Rate changes, making monetary policy less effective in rural areas.

2. Components of a Formal Financial System

A formal financial system consists of four main pillars:

  1. Institutions: The intermediaries (Banks, Insurance Co).
  2. Markets: The platform where trading happens (Stock Exchange).
  3. Instruments: The products traded (Shares, Bonds, Cheques).
  4. Services: The value-added services (Leasing, Advisory).

Summary

  • Goal: Mobilize savings to productive investment.
  • Sectors: Organized (Regulated) vs Unorganized (Unregulated).
  • Pillars: Institutions, Markets, Instruments, Services.

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